CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Sagar Pharma Ltd's debentures of face value ₹1,000 carry a coupon of 10% and are redeemable at par after 5 years. They are currently quoted at ₹950. Using the approximation formula for pre-tax cost of debt, [I + (RV - NP)/n] / [(RV + NP)/2], what is the pre-tax cost (nearest 0.01%)?
The pre-tax cost of debt is 11.28%. Annual interest is ₹100 and the yearly amortised gain on redemption is ₹10, totalling ₹110. Dividing by the average of redemption value and net price, ₹975, gives 11.28%.
- A10.00%
- B11.28%Correct
- C10.53%
- D11.00%
Explanation
I = 100; (RV - NP)/n = 50/5 = 10; numerator = 110. Denominator = (1000+950)/2 = 975. Kd = 110/975 = 11.28%. 10.53% is 100/950, the current yield, which ignores the redemption gain. 11.00% is 110/1000, which uses face value as the base instead of the average.
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